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In times of all-time low APYs in Traditional Finance, more users than ever turn into DeFi yield farming to earn passive income. And indeed, if you want to give a boost to your earnings in the crypto industry (and know what you’re doing), yield farming can be quite lucrative.
However, even while DeFi protocols love to promise high earnings, yield farming is not as easy as it first seems, often involving complex strategies executed across multiple pools and protocols.
How Does Yield Farming Work?
To understand the matter at hand, it’s essential to explain what yield farming is and how it works.
Simply put, yield farming is when you execute a complex strategy across multiple decentralized finance protocols involving several coins and DeFi activities like lending, staking, borrowing, token swaps, and liquidity provision to maximize your returns.
This can be something as simple as supplying liquidity to a pool via an automated market maker protocol like Uniswap, PancakeSwap, or Curve Finance and then staking your liquidity provider (LP) tokens to earn native coin rewards on top of the trading fees.
However, more advanced tactics often yield better results for farmers. For one, here is a detailed strategy you can execute on Fringe Finance, a DeFi lending protocol, to maximize your earnings:
- Connect your DeFi-compatible cryptocurrency wallet with Fringe Finance.
- Deposit stablecoins to the platform via a smart contract to start earning interest on them.
- Immediately after, the protocol mints interest-earning fTokens proportional to your deposit’s size. These assets represent the stablecoins you supplied to Fringe as well as the interest earned on them.
- Stake your fTokens to start accumulating farming rewards in the native $FRIN token.
- Simultaneously, stake the $FRIN you receive as a reward to earn a portion of the fees charged on the Fringe Finance platform.
- After some time, unstake your fTokens and redeem them to unlock your stablecoin deposit and the earned interest.
- While continuing to stake $FRIN, maximize your returns by reinvesting (depositing and lending out) your initial stablecoin principal and the accumulated yield on Fringe Finance.
Now, as we have explored how yield farming works, it’s time to see the most important factors you should consider before allocating your coins to a pool.
No Risk, No Return
In DeFi, a typical adage to follow is "the higher the yield, the higher the risk." Decentralized Finance tends to offer astonishing returns, but it is important to understand the risks.
And this statement also applies to yield farming, which is facilitated by smart contracts to make the process decentralized and decrease counterparty risks. On the other hand, a vulnerability in a contract’s code can still be exploited by hackers, which can lead to grave consequences. Furthermore, its increased complexity makes yield farming a bit riskier than most other methods you can use to earn money in crypto.
Most of the time, the best returns are available as part of incentives programs or when a user is early to a particular farm. Still, high yields often signal high risk. Newer, less "battle-tested" projects are often more prone to be exploited by attackers or turn out to be outright scams.
Considering all the above factors, yield farmers should choose the DeFi protocols and farms that match their risk tolerance. Instead of pouring your entire portfolio (or life savings) into a single farm, you should assess the level of risks you are willing to take and only allocate what you can afford to lose.
Before you deposit any assets into a farm, make sure to thoroughly analyze the team's website, documents, and social channels. In particular, look for audit results and see how professional the firms issuing those are. If something seems suspicious or a project's footprint is nothing to write home about, be extremely cautious.
Take Crypto Volatility Into Account
Unless you work exclusively with top stablecoins, you have to take your crypto holdings’ volatility into account. An extreme price swing in either direction can quickly wipe out your returns.
Volatility can cause the most havoc if you use too much leverage – or borrow funds at the highest LTVs very close to the liquidation threshold – for yield farming. In such a case, a weekly 10-20% drop in the value of your collateral can be enough to force-liquidate your position and completely mess up your yield farming strategy.
At the same time, high volatility increases the risk of impermanent loss. IL occurs when the dollar value of your tokens is less at the time of the withdrawal than when you started supplying them to a pool on an automated market maker (AMM) protocol.
For these reasons, volatility – and its negative consequences, such as force liquidations and impermanent loss – is an important factor in determining the profitability and the risks of your yield farming strategies.
The best way to avoid this risk is to utilize stablecoins exclusively for farming, as they are not subject to the excessive price swings of non-stable cryptocurrencies. Alternatively, you can use the services of a DeFi insurance provider or decrease your leverage (or borrow at lower LTVs) to protect your assets against volatility.
Research
In the DeFi ecosystem, knowing how to play the game to earn on your holdings means mostly being aware of the risks and best practices to follow.
Moreover, as revealing the best yield farming strategies can mean losing an edge, most top farmers are secretive about the lucrative farms they use.
The best way to learn how to conquer yield farming is to have skin in the game. Before putting your money into anything, research every DeFi project and farm extensively to avoid an unpleasant surprise. At the same time, using a small sum to test new strategies before making a considerable investment.
Be aware of the risks, and know that if you bet everything on one or two plays at the shot of a quick return, you could lose everything.
Active Yield Farmers Earn the Best Returns
Yield farming is not so much of a "trading" activity. However, it definitely requires many of the same skills. The best yield farmers know how to rotate their holdings across farms and develop complex strategies that involve frequent changes.
Yield farming also requires an understanding of the importance of risk management and discipline, two skills essential to successful trading.
As the crypto market functions 24/7, many of DeFi's power users treat yield farming as a full-time job. Since things move so fast in crypto, the most committed yield farmers monitor their positions daily and always keep an eye out for the best places to rotate their holdings.
Is Yield Farming for You?
Yield farming can be a ludicrous opportunity for many. However, unlike what some "financial gurus" may say, it's not a get-rich-quick scheme that earns you easy money without any risks.
On the contrary, you have to put real effort into learning the ropes to maximize your chances of success.
Never forget that you may have to take high risks to earn high returns most of the time. This means you have to dedicate some time to assess your risk appetite and only invest the funds you are willing to lose.
If these risks are too much for you, you might achieve better results with staking or lending via DeFi protocols that are generally considered safer alternatives within the crypto community.
Author Bio
Brian Pasfield is the CTO at Fringe Finance with almost 10 years of expertise in blockchain, cryptocurrency, fintech and DeFi. He has delivered technically-complex projects that have leveraged his engineering background and keen understanding of the industry trends and philosophies. Brian has also worked with industry blockchain bodies to lobby for legislation and government policy changes.
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.